Public goods are goods that would not be provided at all in a free market
They are goods that are of benefit to society, the lack of it in a free market is considered to be a market failure
Ex. National defense and flood barrier
Quasi public goods Ex. Street light
Two characteristics of the lack of public goods in free market
They are non-excludable and non-rivalrous
It is pointless for private individuals to provide the goods themselves
A good is said to be non-excludable if it is impossible to stop other people consuming it once it has been provided
Free rider problem "When no one will pay for public good but in the hope that someone else will do it"
A good is said to be non-rivalrous when one person consuming it does not prevent another person from consuming it as well.
The private benefit from public goods would be very small relative to the cost, although the social benefit would be huge and probably greater than the cost.
Government intervention
They may provide the public goods themselves
The use of taxpayers' money to fund the provision spreads the cost over a large number of people who would not be prepared to pay individually
They may subsidies private firms, covering all costs, to provide the good.
Merit goods are goods that will be under-provided by the market and, because of this, they will be under-consumed.
Provide positive benefits for both the people that use them and society as a whole
Government think that such goods should be consumed to a greater degree.
Ex. Education, health care, sports facilities
Governments will attempt to increase the supply of the merit goods depending upon how important they think the merit good is.
Extremely important merit goods, the government may well provide them directly or subsidize them to the point where they are available at no direct cost to the consumer.
The cost is simply shared among taxpayers
Demerit goods are goods that will be over-provided by the market and, because of this, they will be over-consumed.
Provide negative benefits for both the people that use them and society as a whole
The government would like to see them consumed to a lesser degree.
Ex. cigarettes, alcohol, hard drugs. child pornography
The government will make extremely harmful demerit goods illegal and ban them completely
Illegal goods will appear in the black market, attracted by the change to make profits by fulfilling an existing demand
Demerit goods that are less harmful in the eyes of the government, will be taxed.
The existence of externalities
An externality occurs when the production or consumption of a good or service has an effect upon a third party
If the effect is harmful, then it is a negative externality
There is an external cost that must be added to the private costs of the producer or consumer to reflect the full cost to society.
Vice versa, for positive externality, there has been an external benefit to add to the private benefits of the producer or consumers.
If there are no externalities of production then MSC = MPC (Chapter 3)
If there are no externalities of consumption then MSB = MPB (Chapter 3)
Negative externalities of production
These occur when the production of a good or service creates external costs that are damaging to third parties.
Mostly environmental problem
The firm has its private costs but then, on top of that, is creating external costs.
MSC > MPC
In free market, this situation would continue because profit-maximizing firms will only take into account their private costs of production.
Government intervention
The government would tax in order to increase the firm's private costs and so shift the MPC curve upwards towards the point of social efficiency.
It is often difficult to measure accurately the pollution created and to put a value on it
It is difficult to identify which firms are polluting and to what extent each firm is responsible
It is often argued that taxes do not actually stop the pollution from taking place
The government could legislate and could ban the polluting firms, or restrict their output in some way
Pass laws relating to measurable environmental standards in the firm's production units.
The firms then will have to increase their private cost
Problems that ban or restriction may lead to job losses and the non-consumption of whatever was being produced, which may have been a valuable product
Cost of setting and then policing standards may be greater
The government could issue tradable emission permits
Market-based solution to negative externalities of production
Tradable emission permits are issued by the government and give firms the license to create pollution up to a set level.
Firms are then allowed to buy, sell, and trade the permits on the market
Cap and trade system
Each firm has a quota of emissions that it is allowed to produce pollution
One problem with this solution is that it does not lead to the reduction of pollution, one the allowable limit has been set.
The government faces a difficult decision when setting an acceptable level of pollution and it is also difficult to measure a firm's pollution output
Positive externalities of production/external benefits
These occur when the production of a good or service creates external benefits that are good for third parties.
Government intervention to rectify the situation
Subsidize the firms that offer training The MPC curve would be shifted downwards by the subsidy and, if a full subsidy were given, then MPC would be the same as MSC and the socially efficient point "a" would be reached
Very difficult for the government to estimate the level of subsidy deserved by every individual firm
The cost of the subsidies would probably imply an opportunity cost
Provide vocational training through the state, by setting up training centers for workers in certain industries
The costs would be high, the trainers may lack the expertise found in the firms, and it may dissuade firms from offering training of their own.
Regardless of the costs, or who pays these costs, economies benefit enormously through the training and retraining of the labour.
The improvement in the quality of labour, a factor of production, can shift out an economy's PPC
Negative externalities of consumption
There are many things that, when they are consumed by individuals, adversely affect third parties.
Ex. cigarettes and secondary smoking
The negative externalities of consumption produced make the MSB in each case less than the MPB.
The private utility is diminished by the negative utility suffered by the third party.
Because there is a free market, consumers will maximize their private utility (benefit) and consume at the level where MSC=MPB.
They would ignore the negative externality that they are creating.
This means consumers would over-consume
Government intervention
It could simply ban cigarette smoking totally-making it illegal to smoke
However, it has a large effect upon the tobacco industry, in terms of shareholders and employment
Lose large portion tax revenue they are getting from the tobacco industry (inelastic product)
The government could impose indirect taxes on cigarettes, in order to reduce consumption
However, the inelastic demand for cigarettes tends to mean that taxes do not manage to reduce quantity demanded very much and so.
While government revenue is raised, quantity demanded does not fall to the socially efficient level.
If taxes are raised too much then experience suggests that people start to look for other sources of supply
This process is illegal and so a black market if formed
The government could provide education about the dangers of smoking and also fund negative advertising.
However, the costs of this may be high, although if taxes are in place, then the revenue could be used to fund these measures.
The doubt as to the effectiveness of education and advertising in terms of reducing cigarette consumption
Positive externalities of consumption
There are certain goods or service which, when consumer will provide external benefits to third parties.
Ex. health care, education
The MSB of consuming health care is greater than the MPB.
These may have a marked effect on the welfare of society if its consumption is increased.
Government intervention
The government could subsidize the supply of health care
The main problem with such a solution is cost.
While this provision is possible in many developed countries, developing countries are not able to fund such schemes.
Do not fully benefit from the positive externalities that re to be gained from the consumption of health care.
The government could use positive advertising to encourage people to consume more health care
Problem is that there may be a high cost to providing the advertising
The beneficial effect of such solution takes long run to see the result.
Short run effect may be minimal
Tee government could pass laws insisting that citizens have vaccination against certain diseases, or have regular health checks
Only if the government provides this free of charge
People often resent laws of this sort being imposed by the government
They see it as an infringement of their civil liberties.
The extent to which the government will intervene will depend on the amount of the external benefits
Common access resources and further threats to sustainability
Different names: common-pool resources and common property resources
Typically natural resources.
One problem with such resources is that it is very difficult or very expensive to exclude people from using them
The fear is that the nature of the resources and the inability to charge for them may encourage overuse or over-consumption, and eventually lead to the depletion of the resources.
Margin utility is the extra satisfaction that a person gets by consuming one more unit of a good or service.
The benefit to the individual outweigh the external cost and give the individual the incentive to keep using the resource
The concept of sustainability
Where the consumption needs of the present generation are met without reducing the ability to meet the needs of future generations
Lack of a price for common access resources, means that they are almost bound to be over-consumed and eventually run out
Alternatively, they may be overused such that the resource is degraded and will not be available as a resource for future generation
Further threats to sustainability
Both high levels of poverty and the pursuit of economic growth result in environmental problems.
Ex. over-exploitation of land, soil erosion, land degradation, and deforestation.
For developing countries, these problems not only compound poverty and low standard of living, but the problems of common access resources or weak regulations result in massive negative externalities and a significant threat to sustainability.
The use of fossil fuels
Another threat to sustainability comes about as a result of the heavy global demand for fuels
The extraction and use of coal, oil, and natural gas generate external costs which may pose immense threats to future generations.
When fossil fuels are burned, the CO2 greenhouse gases are emmited
The potential consequences of climate change are vast and include the flooding of coastal areas, changes to agricultural patterns, and extreme weather.
Massive external costs associated with these changes.
Carbon monoxide emissions are the major contributor to air pollution
The emission contribute to acid rain, which cause problems for agricultural harvest and building
Also a risk of oil spill
Leads to significant health and environmental consequences in the regions
Government responses to threats to sustainability
Cap and trade system
The government set national targets for emission reduction and encourage firms to meet the target by creating an economic incentive to reduce emission.
Clean technologies
Much attention has been paid to the use of renewable sources of energy as a solution in substituting the negative externalities created by the extraction and use of fossil fuels
Government can assist by subsidizing the development of clean technologies or by offering tax credits to firms that invest in clean technologies
The extent to which governments are willing to subsidize such technologies depends on many things.
The commitment and wills of the government
There is an opportunity cost involved, as the money that is spent on the subsidies will not be able to be spent on achieving other government objectives.
Market forces are, therefore, exerting a positive force as consumers with an understanding of the threats to sustainability are effectively requiring more responsible behavior by firms.
To meet the demand of consumers, firms include a commitment to sustainability as part of their corporate social responsibility codes
Imperfect information
Asymmetric information
Where one party in an economic transaction has access to more information or better information than the other party
Market failure: If either party has information that is incomplete or inaccurate as they will make decisions that do not result in the most efficient allocation fo resources.
In asymmetric information case, the producers have more information than the consumer, and can charge a higher price than is socially efficient (Too many resources have been allocated to the good)
When consumer has more information, they pay a price that is lower than the socially efficient price. (Too few resources have been allocated)
Governments may try to improve the flow of information and set regulations to prevent prdocuers from taking advantage of a lack of information on the part of consumers
It is too expensive and may not be possible for all market
Producers and consumers value their "right" to make private decision
Imperfect competition
Monopolist, and other imperfect markets, restrict output in order to push up prices and maximize profits.
Government intervention
They may use legal measures to make market more competitive.
They may pass laws that do not permit mergers or takeovers that give an individual firm more than a certain percentage of the market
They may set up regulatory bodies to investigate markets where it is felt that monopoly power is being used against the public interest.
Summary
This chapter explains the various types of Market Failure. It states the different Market Failure and its influence to the domestic market. This chapter also talked about positive and negative externalities and its impact on the economy. This chapter relates to real-life situation and talk specifically about these cases.
Questions
What is considered as negative externalities and what is its impact on the society?
Why is negative externalities such as pollution hard to be controlled?
Explain the advantage of planned economy in terms of market failure
Why is environmental issues a problem to economy?
What are some government intervention in supporting of possible externalities, what is it advantage and consequences?
This video uses a humorous animation to illustrate the effect of negative externalities. It talked about the how one simple action that can result in a tremendous consequence in the environment.
"Negative Externalities." Negative Externalities. Economic Online. Web. 24 Nov. 2014.
This PPC graph shows how the negative externality of consumption affect the market. The demand and supply curves are tilted and created an external cost.
Original Awesomeness
This picture shows the positive externality of consumption. The government wishes to increase the demand of such product to benefit the future generations.
Summary
Questions
Found Awesomeness
https://www.youtube.com/watch?v=zcPRmh5AIrI
This video uses a humorous animation to illustrate the effect of negative externalities. It talked about the how one simple action that can result in a tremendous consequence in the environment.
"Negative Externalities." Negative Externalities. Economic Online. Web. 24 Nov. 2014.
This PPC graph shows how the negative externality of consumption affect the market. The demand and supply curves are tilted and created an external cost.
Original Awesomeness
This picture shows the positive externality of consumption. The government wishes to increase the demand of such product to benefit the future generations.